Plan financing to cope with price swings

In the boom time, everyone wanted to do it their way. With iron ore at $US180 a tonne and thermal coal at $US150 a tonne, resources projects were “gold-plated”. Miners could afford to throw money around and lenders didn’t mind, so long as interest payments were made.

Times have changed. Now projects must be planned with costs as low as possible so companies can survive swings in commodity prices. The high cost of building infrastructure in Australia is not a myth. We are not looking at all competitive on a global scale. Are investors still interested?

With this much doom and gloom, lenders are a little nervous, says NAB head of advisory John Martin. “Whilst the cooling of the price boom has been attracting much publicity, it has been unfolding over the past year and there has been a growing focus by both debt and equity providers on which projects are viable at lower commodity prices,” says Martin. “For higher-cost projects, financing is definitely tighter.”

The investment community is divided into two camps, he says. Doomsayers predict an outright collapse in resources markets, with only the big projects with very low costs surviving. Hedge fund managers tell Martin it’s all going to go to custard. Realistic long-term forecasts for commodities prices are the new essential determinant in feasibility planning, he says.

Iron-ore prices a decade ago were only $US20 or $US30 a tonne, “but I don’t think we’re going back there”. Prices will be “wobbly” for the next 20 years, but the long boom in volume and high cost of extraction will ensure the market will deliver a long-term average price miners should be happy with.

“While the overall profitability of the sector will be lower this year, we need to focus on the general trend over the next 20 years, not short-term price movements,” Martin says.

“If you see Australia as embedded in the value chain of the strongly growing Asian economies, then the prospects for our resource sector remain very good – and this is the consensus view amongst more lenders.”

In this market, large low-cost projects are looking good (read Roy Hill), Martin says, whereas high-cost thermal coal projects are standing out for all the wrong reasons. The Wiggins Island coal port expansion is under close scrutiny for this reason. The Glenmore-Xstrata merger is compounding the issue.

But have no fear, lenders are there. Banks, infrastructure funds, the US private placement market and Canadian pension funds are keeping an eye on us.

“There are many potential sources of funding locally and offshore across the spectrum of infrastructure that all the projects are going to need,” says PwC energy, mining and utilities leader, Jock O’Callaghan.

“The challenge is in aligning the interests of [the various resource owners] so that a deal can be done.”

Low yields are attractive to investors, as long as they are certain yields. “The quid pro quo is if they’re going to bring their money to the table, they need to have a high degree of certainty around cash flow.”

Finding funding for a mine owned by one party, producing one resource, can be a fairly straightforward negotiation, O’Callaghan says. But making investment attractive in a rail or port asset serving multiple projects, all with different timelines and drivers, is far more of a challenge. Not many commodities are interchangeable, so it’s not as easy as it sounds to send iron, copper, coal and uranium all down the same rail link, for example. A major complication is that offtake agreements must be locked in before lenders are interested, he says.

Sometimes the project will be built by the company, and so the funding question will take into account the credit position of the company. “What we find drives a lot of this decision making among the miners and the oil and gas companies is: they need these assets, but they don’t want them,” O’Callaghan says. Running trains or a power station is probably not a core competency for a resources company. “Taking on that development risk of building a power station and the technical competency associated with it is not something they really want to develop as a core competency.”

A mine with a 50-year life might seem like a good match for a rail line with a 50-year life, but the relative returns on the assets upset the overall funding balance of the company. If assets are housed in a separate vehicle, the sources of funding that are attracted to low but stable yields are going to be interested.

To make themselves attractive to lenders, resources companies must decide how an asset should be shared, and how much operational and build risk is going to be shared. “You have this merry dance which goes on,” he says. “Until you get a position where all the stakeholders are comfortable with their relative positions, you don’t get the necessary contract signed that will then give the lender to say, right, now I’m on board and here’s my money.”